Ahead of our upcoming webcast with a group of senior NYSE Staffers – “The NYSE Speaks ’09: Latest Developments and Interpretations” – the NYSE has issued proposals to amend its corporate governance listing standards. These proposals will be analyzed during the program. It’s been quite a while since the standards were last revised…
Where Were the Lawyers? Judge Rakoff Asks in BofA Settlement Case
Back from vacation and I see that things have heated up in the case where US District Court Judge Jed Rakoff’s decision to not approve a $33 million settlement between the SEC and Bank of America over allegations of misleading proxy materials because the bonus obligations due to Merrill Lynch employees were not fully disclosed. When I left a few weeks ago, the Judge was about to hold a hearing to discuss the issues involved. At the hearing, he asked for briefs from both parties by August 24th.
On the 24th, the SEC and Bank of America submitted the briefs as requested by the Judge. Here is the brief submitted by the SEC, including the controversial Disclosure Schedule that was not included in the proxy materials as Exhibit A. Here is Bank of America’s brief that asserts that obligation to pay bonuses was disclosed.
As noted in this NY Times article, Judge Rakoff’s request for documentation regarding who was responsible for the decision not to disclose Merrill’s bonuses resulted in both parties blaming the lawyers in their briefs. Although as Tom Gorman notes, “The briefs read as if they were filed in two different cases.”
On August 25th, Judge Rakoff – apparently not very happy with the briefs – issued this order. As noted by Barbara Black in the “Securities Law Prof Blog“:
Judge Rakoff still isn’t satisfied with the explanations given to him by the SEC and the Bank of America about the settlement involving the disclosure (or lack thereof) of Merrill bonuses in the BofA proxy statement. He instructed the SEC to provide more explanation about why it didn’t follow SEC policy and seek penalties from individual defendants. He also didn’t accept the agency’s explanation that its hands were tied because the corporation asserted reliance on advice of counsel as a defense and would not waive the attorney client privilege and give the SEC the documents. How could the corporation base a defense on attorneys’ advice without disclosing the advice? The judge asked for further submissions due September 9th.
The Judge could hold a second hearing on the settlement – or he could approve or reject it after receiving this new rounds of briefs.
Here are a number of commentaries on what has transpired so far:
Last Friday I blogged about the “grass roots” letter writing campaign that had been ginned up to oppose the SEC’s access proposals. It being a slow news week in Washington, it seems that reporters have turned to reading some of the more serious comment letters on the proposals, as a number of stories came out this week, mostly covering the level of opposition to the proposals. For example, this WSJ article notes some of the various suggestions for tweaking the proposals both from those for and against the changes, all seemingly made against the backdrop of a strong presumption that something will be adopted in November of this year. (The WSJ article also notes that the US Chamber of Commerce was behind the small town letters expressing concern over adoption of the access proposal, with more efforts expected to be ramped after Labor Day.)
I thought that I would highlight a couple of letters that caught my eye which have very little to do with the particulars of the proposals, but nonetheless make a case that, once again, now might not be the right time to move forward with implementing a new access regime. In this letter from several former SEC Senior Staffers, they credibly note “[w]e are, however, concerned that at this particular juncture in its history, it would be a mistake for the Commission to divert its resources to these matters. Simply put, there are far more important regulatory matters on its agenda.” The letter goes on to point out:
Importantly, each of these subjects is of far more immediate concern to the SEC than proxy access. Proxy access is a regulatory problem that the Commission has labored to address for virtually the entire history of the Commission. As the proposing release notes, the Commission has considered the problem in virtually every decade, in 1942, 1977, 1980, 1992, 2003, 2007, and last year, in 2008. On each occasion the Commission began with bold proposals to fundamentally revamp the process and concluded with modest actions that, frankly, accomplished little. This disappointing history is not a criticism of past Commissions. Rather it demonstrates that the problem is complex and the Commission’s legal authority to act in this area is limited. The substance of corporate governance remains a matter of State, not Federal, law. Absent Congressional action to dramatically alter the Federal / State landscape (which this group does not necessarily endorse), the SEC will never have the ability to change the governance of corporations meaningfully.
Another letter of note is from the Shareholder Communications Coalition, which has been around since 2005 and is made up of The Business Roundtable, The National Association of Corporate Directors, The National Investor Relations Institute, The Securities Transfer Association, and The Society of Corporate Secretaries & Governance Professionals. This group essentially argues that moving forward with access would involve putting the cart before the horse, by making such a significant change to director elections without addressing some real underlying systemic problems with the proxy system. Among the issues noted that need to be addressed were empty voting, hidden ownership, over-voting, the lack of competition with proxy administrative services, the enormous (and growing) influence of proxy advisory firms. These are all hopefully issues that the SEC is currently studying as it has undertaken a review of shareholder communications and the proxy system.
This is a road that we have all been down before, and many of the same arguments for and against are playing out all over again. We should know pretty soon whether history is destined to repeat itself.
SEC Settles Naked Shorting Cases
Earlier this month, the SEC announced that it settled enforcement actions for violations of the rules designed to prevent abusive naked short selling. Charged in the cases were two options traders and their broker-dealers, who were alleged to have violated the locate and close-out requirements of Regulation SHO. These cases involved conduct spanning from 2005-2007. No doubt that more such cases are in the works.
As part of its efforts to stamp out abusive short selling practices, the SEC announced plans for a public roundtable on September 30 to discuss securities lending, pre-borrowing, and possible additional short sale disclosures.
The Curious Case of Jaycee James
In his Section16.net blog, Alan Dye notes that last week the SEC initiated a cease and desist proceeding against a guy by the name of Jaycee James, who allegedly filed 83 Forms 3 and 4 and Schedules 13D, relating to 29 different companies, all to report fictitious transactions and holdings (see In re Jaycee James, Rel. No. 34-60529). No fraud is alleged, just reporting violations. What on earth would make someone feel compelled to file fake Section 16 reports? I am not sure if I want to find out.
Alan also recently blogged about the Staff’s latest Section 16 C&DI, noting:
The staff’s update of its Compliance and Disclosure Interpretations on Friday included a new Section 16 interpretation, applicable to reverse stock splits. CDI 117.03 says that Rule 16a-9(a), which exempts from Section 16 “the increase or decrease in the number of securities held as a result of a stock split or stock dividend applying equally to all securities of a class,” exempts the cashing out of an insider’s fractional interest resulting from a reverse stock split, so long as the cash-out feature of the stock split applies equally to all holders of the class. The availability of Rule 16a-9 to exempt the disposition of fractional interests for cash had been uncertain (as discussed on pages 508-509 of the 2008 edition of the Section 16 Treatise and Reporting Guide). The new CDI means that insiders will not need to file a Form 4 to report the disposition of fractional interests in connection with a typical reverse stock split.
If you don’t have access to Section16.net, be sure to check out our “Rest of 2009” rates.
At the risk of saying anything about health care reform (lest I be attacked by an angry Town Hall-roving mob), I had not really considered the connection that may exist between the debate over health care and the debate over executive compensation until I saw these letters sent out last week by Representative Henry Waxman (D-CA) and Representative Bart Stupak (D-MI). Representative Waxman is, of course, the Chairman of the House Committee on Energy and Commerce, and Representative Stupak is the Chairman of that Committee’s Subcommittee on Oversight and Investigations.
The letters request that 52 health insurers provide five years of essentially Summary Compensation Table data for each employee or officer who was compensated more than $500,000 in any one of those years, as well as five years of compensation data for the board of directors. The letters also seek, among other things, information about company-paid outside conferences, retreats or events, company financial performance, documents used by the compensation committee in developing or applying compensation plans, and details about the companies’ health care insurance products. Some of the information must be provided by September 4 and some by September 14.
A number of the insurers are public, while others are not (including, e.g., a number of Blue Cross/Blue Shield systems), but in any event developing the compensation data and the other requested information will likely be quite a chore. The letters from Waxman and Stupak follow a letter from Representative John Dingell (D-MI) and Representative Sander Levin (D-MI) to Blue Cross Blue Shield of Michigan asking about executive compensation and a series of rate hikes.
It is not yet clear how the compensation and other information will be used by the Committee in the course of its deliberations on health care policy, or whether this is just a political move designed to demonize the insurance industry through the perennial hot button issue, compensation. I think that I will keep my thoughts on that topic to myself.
Treasury Responds to TARP Criticisms
Recently, the Treasury released responses to recommendations made in the GAO’s June report on the TARP programs, as well as a handful of recommendations from prior reports. The Treasury’s responses indicate general progress on the development of TARP programs. The Treasury’s Office of Financial Stability has 194 full-time employees with a goal of reaching 225, internal controls have been put into place and it appears that efforts toward increasing the tracking of funds and the transparency with respect to recipients are beginning to pay off. But much still remains a work in progress; Treasury is still in the process of developing a risk assessment procedure for the programs, is continuing to renegotiate existing vendor conflict of interest mitigation plans and is considering ways in which to provide more information about the costs of TARP contracts and agreements. The Treasury will have more recommendations to respond to soon – the GAO is required to issue a report on Treasury’s operation of TARP every 60 days.
Former SEC Commissioner Paul Atkins Joins the Congressional Oversight Panel
Speaking of TARP accountability, it was announced last week that former SEC Commissioner Paul Atkins will join the Congressional Oversight Panel, which was set up to oversee the expenditure of TARP funds. The Chair of the Oversight Panel is Harvard Law Professor Elizabeth Warren. Atkins will fill a slot vacated by former Republican Senator John Sununu,
The SEC announced the appointment of Jim Kroeker as Chief Accountant for the Commission. He has been serving as Acting Chief Accountant since the beginning of the year, and during that time he has been quite busy, focusing on fair value issues, among many others. Before coming to the SEC as Deputy Chief Accountant back in February 2007, Jim had been in Deloitte’s national office. It is nice to see someone serving as “Acting” to get the permanent slot, for a change.
Minding Your HSR Compliance for Equity Compensation Programs
When you mention the Hart-Scott-Rodino Act, it usually evokes images of mergers and acquisitions, but HSR compliance should not be viewed so narrowly. As noted in this O’Melveny & Myers LLP memo, the Federal Trade Commission has long taken the position that the HSR Act is applicable to the acquisition of any voting stock, including an acquisition by an individual. As a result, companies and their officers and directors need to be cognizant of tripping HSR filing and waiting period requirements, and the potential consequences of non-compliance (including significant fines).
The O’Melveny memo notes that these types of events could potentially result in an HSR filing requirement if the value of the transaction exceeds the HSR Act’s jurisdictional thresholds and no exemption applies:
an acquisition of voting stock upon the exercise of a stock option or warrant (except for a true same-day, cashless net exercise);
a grant of restricted stock where the grantee receives the right to vote the securities at the time of grant;
the vesting of restricted stock units;
a purchase of voting stock in an open market transaction;
a purchase of voting stock pursuant to a dividend reinvestment plan; or
a purchase of voting stock pursuant to an employee stock purchase plan.
Some companies reimburse officers and directors for filing and legal fees associated with HSR compliance, and the memo notes that such reimbursement amounts generally get reported as perquisites in the Summary Compensation Table.
New Treasury and SEC Regulations and the ARRA: Executive Compensation Restrictions
We have posted the transcript from our recent CompensationStandards.com webcast: “New Treasury and SEC Regulations and the ARRA: Executive Compensation Restrictions.”
We just sent out the July-August 2009 issue of The Corporate Executive, along with a Special Supplement. This issue is devoted to in-depth analysis and practical guidance on the SEC’s proposed changes to the executive compensation disclosure rules. The issue includes:
– The SEC’s Proposed Changes – And their Effects
– The Relationship of Compensation and Risk
– A Broader Scope to the CD&A (But Only When Material)
– Revisiting Equity Award Disclosure – Some Welcome Relief
– A Troublesome Result – And a Fix
– Compensation Consultant Disclosure: An Interim Step?
– Other Important Areas Where Comment is Solicited – And Our Comments
– Walk-Away Disclosure and Analysis – A Heads Up
– Are You Recognizing Too Much Expense for Your ESPP?
– Limits Reduce Employee Returns
– Accounting Considerations
– Proxy Disclosure Updates – Full Walkaway Model CD&A
– Treasury’s Mark Iwry to Speak at 6th Annual Executive Compensation Conference
Subscribing to The Corporate Executive is now more important than ever, particularly given all of the changes contemplated with executive compensation and SEC disclosure requirements. In recognition of the need we are serving this year (and in view of the tight economic times), we are extending a special offer for new subscribers which will enable anyone to receive The Corporate Executive at no risk. If you sign up now for 2010, you can get the July-August 2009 issue on a complimentary basis and the rest of 2009 for free.
FASB Deliberates on Loss Contingencies
Last week, the FASB took up its controversial 2008 proposed changes to the standards regarding disclosure of loss contingencies. As Edith Orenstein notes in FEI Financial Reporting Blog, the August 19 meeting focused on litigation contingencies, with other types of loss contingencies to be taken up at a later meeting. The Board didn’t rule out an effective date by the end of this year, however it appears that the possibility is pretty remote. Here are highlights of the deliberations from the FEI Financial Reporting Blog:
Disclosure objective: The board agreed on the following disclosure object for loss contingencies: An entity shall disclose qualitative and quantitative information about the loss contingency to enable a financial statement user to understand the nature of the contingency and its potential timing and magnitude.
Disclosure principles: The board agreed on three broad principles for loss contingencies:
1. Disclosures about litigation contingencies should focus on the contentions of the parties, rather than predictions about the future outcome.
2. Disclosures about a contingency should be more robust as the likelihood and magnitude of loss increase and as the contingency progresses toward resolution.
3. Disclosures should provide a summary of information that is publicly available about a case and indicate where users can obtain more information.
Quantitative disclosure requirements: The board directed the staff to develop an approach that would focus on disclosure of non-privileged quantitative information that would be relevant to making an estimate of the potential loss, for consideration by the Board at a future meeting.
Reasonably possible equals more than remote: The board decided to maintain the existing requirement to disclose asserted claims and assessments whose likelihood of loss is at least reasonably possible and to clarify that at least reasonably possible and more than remote have the same meaning.
Disclosure of certain remote contingencies: The board agreed that certain remote loss contingencies should be disclosed, and the board directed the staff to develop possible approaches for discussion at a future meeting.
Unasserted claims: The board agreed to maintain existing threshold requirements for unasserted claims and assessments and agreed to enhance the existing interpretive guidance about the threshold.
Recoveries, indemnifications, and settlement negotiations. The board agreed that:
entities should not consider the possibility of recoveries from insurance or indemnification arrangements when assessing whether a contingency should be disclosed.
to require disclosure about possible recoveries from insurance and other sources if and to the extent that the information has been provided to the plaintiff in discovery.
not to require entities to disclose information about settlement negotiations.
Secondary Liability Legislation: Does it Have Legs?
At the end of July, Senator Arlen Spector (D-PA) introduced a bill that would amend the Exchange Act to permit private civil actions against secondary actors for securities fraud, seeking to override the Supreme Court’s rulings in Central Bank and Stoneridge. The legislation would provide that anyone who knowingly or recklessly provides “substantial assistance” to a primary violator will be deemed to have violated the statute to the same extent. Given the current environment, there is at least some chance that this kind of legislation might get support, although at this point it may be too soon to tell.
The Administration recently released the last piece of draft legislation for its financial reform agenda. The legislation is focused on creating a comprehensive system of regulation for the credit default swap market and all other OTC derivative markets. The draft bill is generally consistent with the framework that the Administration outlined back in June, and the overall thrust of these proposals is to encourage the movement of OTC derivatives transactions from unregulated over the counter markets to regulated exchanges and centralized clearinghouses.
Of all of the draft legislation that the Administration has advanced thus far, I think that this bill is the most far-reaching, in that it essentially creates a new regulatory system where pretty much nothing in the way of government regulation (other than, e.g., capital standards) had existed before. The components of the contemplated regulatory system include:
Centralized clearing of standardized OTC derivatives through CFTC- or SEC-regulated clearing organizations;
A requirement that standardized OTC derivatives would be required to be traded on a CFTC- or SEC-regulated exchange or alternative swap execution facility;
An “encouragement” to use standardized OTC derivatives, with higher capital requirements and higher margin requirements applicable to non-standardized derivatives;
Transparency through confidential reporting of positions to federal regulators and public data regarding aggregated open positions and trading volumes;
Federal regulation of any firm dealing in OTC derivatives and firms taking large positions in OTC derivatives;
Strict capital and margin requirements for all OTC derivative dealers and major market participants through the SEC or CFTC;
Tools for the SEC and CFTC to prevent manipulation, fraud and abuse; and
A tightened definition of those eligible investors who may engage in OTC derivatives transactions.
While it is certainly hard to believe that the end of the August recess is almost upon us, it still seems highly likely that Congress will take up derivatives legislation when they get back in town. The Administration’s proposals closely track the agreed-upon guidelines for derivatives legislation reached by Representative Barney Frank (D-MA) and Representative Collin Peterson (D-MN). Further, a number of bills seeking to enhance OTC derivatives regulation have already been introduced in Congress. For example, on the House side, Agriculture Committee Chairman Peterson introduced H.R. 977, which is pending before the House Financial Services Committee. Moreover, H.R. 2454 was introduced by Energy and Commerce Committee Chairman Henry Waxman (D-CA) and includes several provisions concerning OTC derivatives regulation. This legislation was approved by the House on June 26. In the Senate, Agriculture Committee Chairman Tom Harkin (D-IA) introduced S. 272, while other bills with provisions targeting derivatives have been introduced jointly by Senators Carl Levin (D-MI) and Susan Collins (R-ME) (S. 961) and by Senator Ben Nelson (D-NE) (S. 807).
The CFTC Response: Not Quite Far Enough
CFTC Chairman Gary Gensler was apparently not a recipient of Treasury Secretary Geithner’s obscenity-laced tirade a few weeks back, so he felt free to comment to Congressional leaders (as noted in this Bloomberg article) on the Administration’s derivatives legislation, asking lawmakers to, among other things, not adopt exemptions for foreign currency swaps and end users that are not swap dealers or major market participants.
Among other recommendations, Gensler also suggests that Congress not move forward with the mixed swap provisions of the Administration’s draft legislation, which provide for the dual SEC-CFTC regulation of swaps deriving value from both a security and a commodity. Rather, Gensler suggests a system where the applicable regulation follows what the value of the derivative is primarily based on. He also suggests Bankruptcy Code amendments to provide protections similar to those afforded in the futures markets.
SEC/CFTC Harmonization
The SEC and the CFTC announced last week that they will hold joint meetings to seek public input on the harmonization of market regulation by the two agencies. The first meeting, to occur on September 2, will be held at the CFTC, and the second meeting will be held at the SEC the next day. The two agencies have until the end of September to come up with a report to Congress which identifies conflicts in their regulation of financial instruments and that makes recommendations for harmonizing the regulations.
Yesterday, the SEC announced that it had experienced problems receiving electronically submitted comment letters on a number of proposing releases, most notably the shareholder access proposals and the proposed amendments to Regulation SHO. The problems occurred during a “brief time” on August 17, although it is not clear from the notice when that brief time occurred. Some folks who attempted to submit comments got e-mails from the Secretary’s office following up, while others did not.
The notice indicates that the Staff believes all comments have been identified, but that commenters might want to contact the Office of the Secretary (202-551-5400) or check www.sec.gov under the comment file for the particular release to confirm receipt of their comments. It is always a good idea to check the online comment file in any event to make sure that your comment letter got through.
The Small Business Voice on Shareholder Access
Some of the comment letters that did manage to get through earlier this week on the shareholder access proposals seem to represent an interesting new trend. Over the last few years, there has developed quite the cottage industry in letter writing campaigns on SEC proposals. In many cases, these coordinated comment responses have come as “form” letters. The Staff has wisely adopted a practice of categorizing the form letters by type, and thereby taking them out of the list of commenters, while still providing the text of the letters. The prevalence of these letter writing campaigns has skyrocketed the comment letter count to numbers in the tens of thousands, which certainly makes the job of putting together a comment summary seem like a daunting task!
With this latest round of shareholder access proposals, we are seeing a wave of individualized letters from small business owners. And here we are talking very small businesses, not, e.g., smaller reporting companies. So, for example, in this letter, Noreka Taylor from Mama’s Kitchen in Kinston, NC writes:
Being a good cook alone is not going to help me make it through the recession. My country and my government should be helping me and my business succeed, not intentionally doing it more harm! Now that I have finally seen an increase in customers and income, my country has decided to try to hurt the economy again. These changes just do not make sense. Putting unqualified appointees into corporate chairs to peddle their own agenda and special interest could not possibly help anyone or anything except lining their own pockets. My restaurant cannot afford these changes and most other small businesses cannot either.
Meanwhile, at Don’s Tractor Repair in Wakefield, KS, Tim Zumbrunn worries that the access rule will put him out of business if his suppliers get caught up in expensive proxy contests. Tim states “[o]ur federal government should not intrude on publicly traded corporations, and corporate state laws should remain intact.” Proxy access is even on the mind of Teresa Liddell at Dust 2 Dust ATV Track and Trails in Thackerville, OK, stating that “[t]he recent proposal by the SEC to change shareholder proxy access and give the government greater access to businesses and their decisions would only hurt us and many other businesses.”
Each of these letters is personalized and describes different ways in which the proxy access proposals might cause harm, so they can’t be easily categorized into “form” letter categories. It is hard to say how much sway these letters will have with the Staff and the SEC as compared to, say, the Seven Firms letter or the letter from the Council of Institutional Investors, but they certainly indicate the lengths to which those opposed to access will go in seeking to undercut the SEC’s proposals.
Robert Khuzami: Breaking the Ice
In a speech before the New York City Bar on his first 100 days as the Director of Enforcement, Robert Khuzami got things started off with this joke:
All that being said, I’m pretty proud of my own 100-day accomplishments. So how have things changed? Before I joined the Division in March, the Dow was struggling around 6500 points. Now the Dow is over 9200. So am I really responsible for a 41% increase in the Dow? I am, and I’d explain it, but it’s very complicated. It involves algorithms, and calculus, and a black box and other … stuff. Now, when I ran this speech by my wife, she looked (kind of like some of you out there) a little incredulous. She said, “you’re not claiming credit for the stock market, are you? While you’re at it, are you also taking credit for the mild hurricane season or the sharp decrease in lethal shark attacks world-wide.” Well I am, and I’d explain it, but it’s very complicated. It involves algorithms, and calculus, and a black box and other … stuff.
The speech went on to note the significant changes being implemented in Enforcement, including the organization of specialized units, the streamlining of management and internal processes, the creation of an Office of Market Intelligence, an effort to foster cooperation by individuals and the expansion of resources throughout the Division, including adding staff to the Trial Unit and hiring a Chief Operating Officer.
I attended the ABA Annual Meeting earlier this month, and at the Federal Regulation of Securities Committee’s “Dialogue with the Director” session, new Corp Fin Director Meredith Cross, along with Deputy Director Brian Breheny, outlined Corp Fin’s agenda. In addition to reviewing comment letters and coming up with recommendations on already proposed rules, the Staff is working on rulemaking initiatives that include:
Expanding Schedule 13D/G reporting to cover short positions. The Staff is also considering changes to the beneficial ownership rules for purposes of 13D/G reporting;
Liberalizing shareholder communications to permit distribution of educational materials to shareholders regarding the proxy voting process, without the materials being deemed a proxy solicitation. The Staff is proposing to conduct a study regarding shareholder communications and will announce the results;
Amending credit rating agency rules to address conflicts of interest;
Improving asset-backed securities registration and disclosure; and
Amending Rule 163 (communications by WKSIs).
The Staff is also:
Keeping track of legislation in Congress to enable them to gear up to quickly to propose any rulemaking mandated by legislation;
Continuing its review of the proposed Regulation D amendments;
Discussing Section 5/short selling issues with General Counsel David Becker to determine how to move forward; and
Conducting a “Core Disclosure” review project for the purpose of reviewing all disclosure rules to ensure that the disclosure is “right” rather than just “more.”
The Staff is in the process of reviewing how the work of Corp Fin is being done and whether any improvements can be made, including in the area of maintaining and expanding transparency. The Staff has been improving the efficiency of such things as responding to no-action and waiver requests. Further, it was announced that a new products team has been established, headed up by Tom Kim and Paul Belvin. This team will coordinate the review of new financial products in the Division, including reviewing new products on a pre-filing basis.
We have posted notes from the “Dialogue with the Director” session (courtesy of Suzanne Rothwell at Skadden) in our “Conference Notes” Practice Area.
FINRA Announces Amendments to Conflicts of Interest Rules
A few months ago, I noted in the blog that the SEC had approved changes to NASD Rule 2720, which deals with underwriter conflicts of interest. Last week, FINRA issued Regulatory Notice 09-49, so the rules will now go into effect on September 14, 2009. The FINRA Regulatory Notice includes some clarifications of the rule. It should be noted for upcoming offerings that, in addition to the procedural safeguards contemplated in the amended rule, more prominent disclosure of conflicts of interest will be required in offering documents. In the Regulatory Notice, FINRA notes that, with respect to a takedown from a shelf registration statement that became effective prior to September 14, the disclosure requirements of the amended rule will apply to any post-effective amendment or prospectus supplement filed on or after September 14.
SEC and FINRA Issue Alert Regarding Leveraged and Inverse ETFs
It is certainly not surprising, given the increased focus on the risks arising from financial products, that the SEC and FINRA are now singling out particular products and highlighting their risks for investors. With the prospect of something along the lines of a financial product safety commission hanging out there to potentially infringe on its authority, I suspect that the SEC in particular wants to be proactive in addressing what could be the next big blow-up.
Earlier this week, the SEC and FINRA issued an Alert highlighting the perils of investing in leveraged and inverse exchange traded funds. In the Alert, the agencies note “[i]nvestors should be aware that performance of these ETFs over a period longer than one day can differ significantly from their stated daily performance objectives.” According to the Alert, inverse ETFs (also called “short” funds) are designed to provide the opposite of the performance of the index or benchmark that they track, which may be a broad market or sector specific index. Leveraged inverse ETFs (also known as “ultra short” funds) seek to achieve a return that is a multiple of the inverse performance of the underlying index.
These are clearly instruments which have a very specific purpose that is probably inconsistent with the type of investing strategy pursued by anyone who needs an SEC/FINRA reminder on the potential dangers of the product. Whether warnings like this one do any good in discouraging people from getting in over their heads – under what is essentially a “caveat emptor” system – is a big question that will be considered as the debate over the regulatory reform landscape continues.
As Broc previously noted in the blog, the FASB Codification project was launched back in July and will be effective for financial statements issued for interim and annual periods ending after September 15, 2009. Under the FASB Codification, existing references to U.S. GAAP materials are replaced by new references, thereby rendering all existing references obsolete.
Yesterday, the SEC issued an interpretive release in order to address the issues for SEC materials that are raised by the Codification. In the release, the SEC indicates that all references to the “legacy” FASB standards (and other private-sector US GAAP literature) in rules, regulations, releases and staff bulletins should be construed as the corresponding reference in the FASB Codification. The SEC notes that it will be embarking on a longer term project to revise U.S. GAAP references in its rules and guidance.
The SEC also asserts its GAAP supremacy in the release, noting that while the FASB Codification supersedes existing U.S. GAAP references from private standards-setters, it does not supersede any SEC rules or regulations. In this regard, the SEC notes that the FASB Codification is not the authoritative source for SEC rules and regulations, which are referenced in the Codification for the convenience of users.
Corp Fin Provides MD&A Guidance on Loan Losses
A new “Dear CFO” letter provides some guidance to financial institutions on what the Staff expects in terms of MD&A disclosure around an institution’s provision and allowance for loan losses. While the disclosure requirements have not changed, the Staff indicates that the current economic environment may require that a company “reassess whether the information upon which you base your accounting decisions remains accurate, reconfirm or reevaluate your accounting for these items, and reevaluate your Management’s Discussion & Analysis disclosure.”
The letter lays out the Staff’s disclosure expectations around high risk loans (e.g., option ARM products, junior lien mortgages, subprime loans), changes in practices for determining the allowance for loan losses, declines in collateral value and other potentially material considerations, such as risk mitigation strategies, the reasons behind changes in key ratios (such as the non-performing loan ratio), and how accounting for an acquisition under FAS 141R or accounting for loans under SOP 03-3 affects trends in the allowance for loan losses.
Benchmarking in the Spotlight
An article in yesterday’s WSJ discussed two new academic studies that have focused on benchmarking practices at public companies. While the article tends to sensationalize the issue a bit, it does note how the studies highlight one of the principal failings of benchmarking, which is the way in which peer groups are selected. In particular, the studies appear to demonstrate a bias toward selection of peer companies with better paid CEOs, compounded by a trend noted in one of the studies that approximately 40% of the companies reviewed indicated that they paid their CEOs more than the median level of comparable pay. In the article, the typical competitiveness arguments are noted in support of benchmarking. The article observes that these studies were made possible by the 2006 amendments to the executive compensation disclosure rules, which require disclosure of the list of peer companies when benchmarking is used.
Obviously this is not any breaking news; rather, what is noteworthy is that there is now some empirical support (which, of course, should always be taken for what it is worth and in consideration of its limitations) for some of the claims about benchmarking. It certainly helps to confirm what then-Corp Fin Director Alan Beller so eloquently said at our conference back in 2004:
“Too many boards have apparently operated on the principle that compensation must be in the top half or even the top quartile of some benchmark group (the basis of selection of which is often not disclosed) for the company to be competitive in attracting executive talent. (This principle apparently operates without regard to whether performance is commensurate to compensation). This approach produces what I have called the Lake Wobegon effect, where everyone is above average. Boards of directors ought to be able to do better than this.”
What can be done now, in light of this new evidence of the obvious? I think that one place to start is the useful guidance provided in the Obama Administration’s broad compensation principles announced in June, which call for developing an improved pay for performance paradigm that is less focused on external competitive positioning and more focused on relative performance of the company, achieved through a diversified set of performance criteria having an emphasis on long-term value creation.
For more analysis of the Administration’s compensation principles, be sure to check out this complimentary copy of the Summer 2009 issue of Compensation Standards. Also note that you can sign up to be a member of CompensationStandards.com for free for the rest of this year when you try a 2010 no-risk trial.
Back in April, the SEC proposed several alternative ways of addressing short sales, including either: (1) a market-wide approach; or (2) a security-specific circuit breaker approach. As I noted in the blog back then, it promised to be a monumental task for the Staff to reconcile the competing approaches and the many comments on the proposals in coming up with a final recommendation.
Yesterday, the SEC took the relatively unusual step of reopening the comment period for the proposals, which had closed June 19th. The SEC noted that it has received approximately 4,000 comment letters, as well as over 250 copies of 4 different standard letters, and a petition with 5,605 signatures. In reopening the comment period, the SEC has focused in particular on an alternative uptick rule, which would permit short selling at a price above the current national best bid. Comment was solicited on this alternative uptick rule in the initial proposing release, but it was not one of the proposals that was specifically advanced. In the new release, the SEC discusses the alternative uptick rule in greater detail and solicits specific comments regarding its potential application.
The reopened comment period runs for 30 days from the date of publication in the Federal Register.
Yesterday was the last day of the comment period for the shareholder access proposals. Some had asked the SEC to extend the comment period, but no such extension was forthcoming. Of course, the Staff and the Commissioners will still consider comment letters that are submitted “late,” although it depends on how quickly the rulemaking is moving as to whether a late letter has any influence. So far, only slightly over 170 comment letters have been submitted by my count, which is a far cry from the thousands of letters received on the prior proposals in 2003 and 2007. Here is Evelyn Y. Davis’s comment letter – surprisingly, she is not in favor of shareholder access!
The UK’s FSA Implements Pay Reforms for Financial Institutions
Last week, the FSA rolled out its compensation reforms applicable to large financial institutions in Policy Statement 09/15. The reforms were originally proposed through a Consultation Paper released back in March 2009. While the principles are limited in applicability to the largest UK banks, building societies and broker dealers (26 firms, as compared to 47 firms under the proposed rules), the FSA indicates in its announcement of the final rules that the Policy Statement “indicate[s] [FSA’s] thinking on what is viewed as good practice (where relevant) to all firms in these groups.” The Remuneration Code set forth in the Policy Statement is set to go into effect on January 1, 2010.
The rules are, of course, focused on the relationship between compensation and risk. The general requirement of the Code is that remuneration policies must be consistent with effective risk management. The Code sets forth a number of remuneration principles, which include:
1. the role of bodies responsible for remuneration policies and their members;
2. procedures and risk and compliance function input;
3. remuneration of employees in risk and compliance functions;
4. profit-based measurement and risk adjustment;
5. long-term performance measurement;
6. non-financial performance metrics;
7. measurement of performance for long-term incentive plans; and
8. remuneration structures (e.g., mix of salary and bonus, bonus deferral, performance criteria, guaranteed bonuses).
With the January 1, 2010 effective date rapidly approaching, the FSA plans to send letters out at the end of August to covered firms, asking for their remuneration policy statements. The firms will be expected to provide their remuneration policy statements to the FSA by mid-October, and then the regulator will hold meetings with the compensation committees and risk committees of the firms between November 2009 and February 2010. Some limited transition relief is provided for firms that have to amend or terminate employment agreements.
The Code puts the UK out in front in terms implemented of pay reforms, although the FSA notes that international discussions on alignment and implementation principles are underway with the Basel Committee on Banking Supervision and the European Council. As noted in this Bloomberg article, however, the FSA’s rule changes have not necessarily been welcomed in the UK, thanks to a belief that the FSA watered down the requirements and ended up leaving banks and brokers with substantial discretion with respect to pay decisions.
TALF Extended into Next Year
Yesterday, the Federal Reserve Board and the Treasury Department announced an extension to the Term Asset-Backed Securities Loan Facility. While acknowledging improvements in financial market conditions over the last few months, the Fed and Treasury noted a bleak outlook in the markets for securities backed by consumer and business loans and for CMBS. They will now be extending TALF loans against newly issued ABS and legacy CMBS through March 31, 2010. Given the time lags involved in new CMBS deals, TALF lending against newly issued CMBS will occur through June 30, 2010.
The Fed and Treasury also announced that they wouldn’t be expanding the types of collateral eligible for the TALF program. They indicate that they will continue to monitor the situation to see if any further extension is warranted, or if any additional collateral should be permitted.